DUBAI, May 31 (Reuters) - The adoption by the United Arab Emirates of certain sharia-compliance standards has slowed the issuance of Islamic bonds from the Gulf, adding to a chronic supply-demand imbalance, market sources said.
Dubai, one of the UAE’s seven emirates, has long aimed to establish itself as a major global centre for issuance of sukuk, or Islamic bonds, that constitute the backbone of the $2.2 trillion global Islamic finance industry. UAE investors are also key players in the global sukuk market.
But compliance standards adopted by UAE central bank body the Higher Sharia Authority, and confusion around them, are preventing local banks from buying some sukuk, prompting investors to request clearer rules as the UAE’s flow of new issuance ebbs, market sources said.
“The market is going through a teething period as it seeks clarity on how to find ways to comply with the regulations,” said Bashar Al Natoor, global head of Islamic finance at Fitch Ratings.
The Higher Sharia Authority (HSA) adopted the sharia standards of the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the standard-setting body for the Islamic financial industry, in 2018. However, issuance programmes created prior to that were exempt from the new rules, sources said, meaning the effect has taken some time to become apparent.
Investors also said disagreement among scholars at UAE institutions over whether Saudi Arabia’s National Commercial Bank’s AT1 sukuk issuance in January was AAOIFI-compliant, and thus adhered to HSA regulations, had rattled potential buyers.
A key issue is around AAOIFI requirements for certain debt instruments’ “tangibility ratio”, which relates to the assets that need to be used as collateral for sukuk to remain sharia-compliant until maturity.
“All this is causing a logjam in issuance and in my view is becoming an existential threat to the long-term viability of the market,” Abdul Kadir Hussain, head of fixed income asset management at Arqaam Capital, wrote in a note.
“Standardisation remains an elusive dream,” he added.
Dollar sukuk issuance from the UAE so far this year totals just $1 billion, compared with $6.35 billion through all of 2020 and $7.9 billion in 2019, according to Refinitiv data.
Despite expectations of an acceleration in global issuance in 2021, there was less than $2 billion in hard currency sukuk sold in the first quarter of this year, versus $7 billion in the same period of 2020, according to Hussain.
This has led to sukuk risk being mispriced, he and others said, as Islamic investors scramble for the few issues on offer, especially AAOIFI-compliant ones.
In March, Arabian Centres sold $650 million in sukuk at 5.625% in a non-compliant deal and drew just $1.35 billion in demand, while Bahrain’s National Oil and Gas Holding Company (NOGA Holding), which has a lower credit score, raised $600 million in eight-year sukuk. Those sukuk, which conform to AAOIFI standards, were sold at 5.25% and attracted more than $2 billion in orders.
The HSA has been holding discussions with investors to address standardisation issues this year, two market sources said.
The central bank did not respond to requests for comment.
Sukuk, which seek to replicate conventional bonds without the use of interest payments, can be complex and time-consuming to structure, and difficult for investors to understand.
AAOIFI’s standards in some structures require the tangibility ratio to be 51% throughout the sukuk’s tenor, meaning assets worth more than half the issuance value are used as collateral.
Investors say this limits the ability of issuers to leverage up, making it more likely for them to issue conventional bonds, and further dent sukuk supply.
S&P analyst Mohamed Damak said if an asset doesn’t perform as expected it can hit the sukuk’s tangibility ratio.
“Because of that the sukuk has to be accelerated - and (if) the corporate doesn’t have the cash on its balance sheet to pay it back - then it’s a risk for the investors,” he said.
“So this is why it’s causing a little bit of a headache for issuers in the UAE.” (Reporting by Yousef Saba and Davide Barbuscia; Editing by Kirsten Donovan)